Retirees Urged to Exercise Care When Facing a Bet-The-Future Decision


Many retirees are facing a bet-your-future decision fraught with significant risks as pension plans offer participants a one-time lump sum payout in exchange for giving up their monthly checks for life. Ford Motor Co. and General Motors Co. made headlines recently when they made that offer to their 130,000 nonunion retirees. With pension liabilities at record levels, and interest rates at record lows for the foreseeable future, other companies are expected to follow suit, turning lump-sum offers into a major trend. (“Lump-sum offers present risks and opportunities,” by Mary Beth Franklin, InvestmentNews).

“I think you will see many plan sponsors offering lump-sum pension payouts over the next 12 to 24 months,” Sean Brennan, a principal and pension plan expert, was quoted as saying. Mr. Brennan, who is affiliated with human resources consulting firm Mercer LLC, explained that one reason for the increase in such offers is that employers can now use a blended corporate interest rate to calculate lump-sum payouts. Introducing the higher blended corporate interest rate result into the formula results in a lower lump-sum than would the lower Treasury rate, which was previously used in such formulas.

The higher the interest (or discount) rate used, the lower the present value (or lump-sum) of an annuity (stream of payments) is.

On the other hand, many private pension plans – those that are less than 80% funded ? can offer participants only half their pension benefit as a lump sum, with the other half convertible to an immediate annuity. Plans that are less than 60% funded are not permitted offer lump-sum payouts.

Those restrictions could change, however, as a result of legislation that provides employers greater flexibility to meet pension-funding obligations. It is important to remember that lump sum payouts are not suitable for everyone and carry significant risks.

“There are people who are very comfortable with fixed monthly payments, particularly when they see volatility in their 401(k) balance, volatility in their [individual retirement accounts], and their home is worth only two-thirds what it was five years ago,” one financial adviser was quoted as saying, adding: “No matter how compelling a lump sum might be, we need to remember our fiduciary duty and respect our clients’ tolerance for investment risk.”

That investment risk is substantial. Even the most sophisticated projections designed to show how long a sum of money will last assuming various return and withdrawal scenarios is not the same thing as a guaranteed annuity for life. In the latter case, the plan bears the investment risk.

Investment losses, especially in the early years of retirement, can have a huge impact on the risk of outliving your money. As one person put it: “What have I learned in life? I’ve learned that if you are down 50% then up 50% you haven’t broken even.” That is because an asset base that is reduced by 50% must earn 100% to break even. Losses can happen with shocking speed and recovery can take a long time, as we have seen.

In addition to market risk, there is also the risk of falling into the hands of an unscrupulous investment adviser. A dishonest adviser who puts his or her financial interest ahead of the client may “promise the moon” in projecting unrealistic returns in order to persuade a plan participant to take the lump sum and invest it with the adviser.

Not all financial advisers are unscrupulous, and it may be that most are not. However, it is undisputable that every financial adviser in this situation has a financial interest in persuading a plan participant to take the lump sum and invest it with him or her, so that he or she can earn fees or commissions, and that this interest conflicts with the client’s interest in hearing all the risks and potential problems that would support a decision to keep the annuity and forego the lump sum.

These are very serious matters. The lump-sum versus annuity decision should not be made lightly. Most importantly, it should be made with the advice of a competent, unconflicted financial adviser ? that is to say, an adviser who does not stand to earn fees or commissions by handling the investment of the lump sum.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.